Q: My son received a scholarship. Can I take out leftover money without a penalty?
A: Yes, you can take out some of the unused 529 funds and avoid penalty (unfortunately not tax) because of the scholarship your son received.
Since you are the owner of the account, you are able to withdraw the amount equal to the scholarship and avoid penalty on that distribution. All distributions are made up of a return of your contributions and growth. You will only pay tax on the growth part of the distribution and not the entire amount.
In this case, you’ll need to take a distribution up to the amount of the scholarship this year, the same year the scholarship was received. This will then be reported on the 2021 return indicating the distribution was penalty free due to scholarship.
529 Plan and Scholarship
Information from www.investopedia.com – “If your child receives a tax-free college scholarship or grant, the amount of that scholarship or grant must be deducted from total qualified education expenses as part of the determination of their AQEE.
The scholarship exception, however, lets you withdraw up to the amount of that scholarship and use the money for any purpose penalty free. The earnings on that portion of the distribution will still be subject to income tax. However, if you use the withdrawal for qualified educational expenses, the money will be both tax and penalty free.
The scholarship clause is important, because if your child does not receive a scholarship (or meet one of the other exceptions) and you withdraw funds that are not used for qualified education expenses, you will owe both taxes and a 10% penalty on the earnings.” Click here to read more in the article.
What to Do With Leftover Money in a 529 Plan
Information from www.consumerreports.org – “There are a few circumstances that could cause you to wind up with excess funds. Of course, it could be because your child didn’t attend college or dropped out of school. But it could also happen if your child won a scholarship, received a family inheritance, enlisted in the military, or went to a school that ended up being cheaper than you expected. Even qualifying for education-related tax credits could reduce the amount you thought was needed.
Fortunately, 529 accounts are very flexible. Funds can be used tax-free for many types of schooling, not just expenses at a four-year college. And there are a number of situations in which you can access the money without incurring penalties. There’s also no time limit on using the funds.” Click here to read more in the article.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
Blog by Brian Biggs, CPA – Financial Advisor, Senior Tax Professional
Learn more about Brian and the rest of the Storen Financial team here.